Sorry, Microsoft Will Not 'Own 30% of the Search Market'

Henry Blodget Does the Math on the Revenue Side of the Deal

Now that the Yahoo deal is finally done, many observers seem to think Microsoft's new search business will be just like Google's -- only a bit smaller.

Specifically, they think that Google has 65% of the market and Microsoft will have 30%, so Microsoft's search business will basically be half the size of Google's.

It won't.

In terms of U.S. query share to be processed by Microsoft's search engine, yes, Microsoft's search business will be about half the size of Google's -- as long as the share doesn't drop in the two years (two years!) it will take to implement the deal. And as long as you ignore international, where Google has a far more dominant query share.

In terms of profit and revenue, however -- which are the only factors that matter when valuing a business -- Microsoft's relative share will still be tiny.

Don't forget that 20% of Microsoft's 30% query share in the U.S. will come from Yahoo. Microsoft will get to keep exactly 12% of the revenue from this share. Eighty-eight percent of the value, meanwhile, will still accrue to Yahoo -- Microsoft will just take a fee off the top for playing the role of transaction-processor.

Microsoft, in other words, will bear all the costs that Google bears for each point of query share, but it will only keep a fraction of the revenue.

Let's put some numbers on this.

Let's assume the U.S. search market generates $15 billion of gross revenue in two years (a bit high, but go with it). Let's assume that query share stays the same (it likely won't) and that Microsoft generates the same revenue per search that Google does (it won't). Here's how the revenue pie would be split:

In other words, Microsoft's query share from the Yahoo deal will more than triple, from 8% to about 28%. But its revenue will only increase about 25% (because the rest will go to Yahoo). And the division's total search revenue will still be a rounding error relative to Microsoft's $40 billion of overall revenue.

Assuming the split above, which is overly generous to Microsoft because Microsoft's revenue per search is much lower than Google's, Microsoft would be generating about $1.5 billion of revenue from its 10% share of the search market. Yahoo's 20% query share would generate gross revenue of $3 billion, but Microsoft will only keep 12% of this. So once it adds the revenue from the Yahoo deal -- about $360 million -- Microsoft's search revenue will increase to $1.9 billion.

Microsoft's profit picture, meanwhile, will be even worse:

Microsoft is currently losing $2.2 billion a year in its Internet division, on revenue of $3 billion. Microsoft's total cost base in the division, therefore, is about $5 billion a year.

All else being equal, assuming that $360 million of Yahoo-revenue-share is pure profit (it won't be), Microsoft's internet division's revenue would increase from $3 billion to $3.4 billion, and its losses would decrease from $2.2 billion to $1.8 billion. So even after the Yahoo deal, the division would still be losing $1.8 billion a year.

Conclusion

Microsoft won't own 30% of the value of the U.S. search market after the Yahoo deal. It will process 30% of queries, but it will only generate about 13% of the revenue (more like 10%, using real-world revenue-per-search stats). It will also likely still be losing money. A lot of money.